What is the biggest reason why the Bank of Japan (BoJ) is not implementing monetary easing? Insights from the International Monetary Fund (IMF)

The Bank of Japan (BoJ) not rushing to change its monetary policy despite the ongoing global inflation is becoming increasingly apparent, and here we will explain the reasons behind this stance.

■　Current Yen Depreciation Trend and Its Underlying Factors

Currently, Japan is experiencing a trend of yen depreciation, but what lies behind this situation?

The current yen depreciation trend is closely linked to the fact that the United States initiated interest rate hikes from 2022 onwards while Japan continues to maintain its accommodative monetary policy and negative interest rates.

This interest rate differential is considered a significant factor in the yen’s depreciation against the US dollar. As a result, Japan heavily relies on imports, especially for energy and food, leading to concerns about the rising cost of living.

This situation has led to the rise of discussions on the concept of “negative yen depreciation.”

■　Factors Delaying BoJ’s Policy Change

Japan’s inflation rate has exceeded the target of “2%” since April 2022 and has not fallen below 2% for 17 months.

In fact, in December 2022, it recorded double the target at 4%, and in January 2023, it exceeded even further at 4.3%.

Additionally, the yield on the 10-year Japanese government bond, known as the yen 10-year bond, has remained stable at 0.25% for an extended period, but the market is anticipating the removal of negative interest rates in Japan and a move towards interest rate hikes, pushing rates towards 1%.

However, as of now, the Bank of Japan’s Governor, Haruhiko Kuroda, continues to support the continuation of accommodative monetary policy.

This is because Japan’s inflation is believed to be of the “cost-push inflation” type, driven by external factors, rather than the “demand-pull inflation” caused by increased domestic demand.

■　Comparison of Japan’s Inflation Structure with International Inflation

Japan’s inflation structure is of the “cost-push inflation” type, which is distinct from the “demand-pull inflation” caused by rising domestic demand.

Let’s take a closer look at this difference.

Japan heavily relies on importing food and energy, and countries exporting these products to Japan have considerably higher inflation rates than Japan.

Consequently, Japan is exposed to rising prices, which, in turn, lead to an increase in domestic prices.

In reality, while inflation in other countries is calming down, Japan’s inflation rate dropped to 3.2% in August 2023 after reaching 4.3% in January.

The Bank of Japan anticipates that Japan’s inflation rate will fall below the 2% target in the near future.

■　Relationship Between Japanese and US Interest Rate Differentials and Exchange Rates

The exchange rate dynamics between the Japanese yen and the US dollar are largely attributed to the interest rate differentials between Japan and the United States.

But how is this relationship constructed?

In response to the United States’ interest rate hikes, Japan has continued its accommodative monetary policy, leading to a substantial gap in interest rates between the two countries.

The United States is working towards taming inflation and might even discuss the possibility of interest rate cuts in the future.

Assuming that this interest rate differential is the cause of yen depreciation and US dollar appreciation, if the United States conducts interest rate cuts, the gap in interest rates is expected to narrow without any action from the Bank of Japan.

■　The Significance of Real Wages and Achieving Inflation Targets

The rise in real wages is of paramount importance to achieving Japan’s inflation target. But what are real wages?

Real wages are calculated by deducting the inflation rate from nominal wages. Currently, Japan has experienced 17 consecutive months of negative growth in real wages.

However, an increase in real wages would allow many people to increase their spending, thereby increasing the likelihood of achieving the inflation target.

Even if the interest rate differential widens and prices rise due to yen depreciation and US dollar appreciation, the Bank of Japan believes that there is no need to implement policy changes to create an environment where wages outpace these developments.

■　IMF’s View on Yen Depreciation

According to the International Monetary Fund (IMF), the United States’ perspective on yen depreciation is that there is no necessity for Japan to intervene in the foreign exchange market to support the yen’s exchange rate.

Sanjaya Panth, Deputy Director of the IMF’s Asia and Pacific Department, made this viewpoint clear during the 2023 annual meetings of the IMF and the World Bank.

Panth suggests that yen depreciation is primarily due to interest rate differentials and reflects fundamental economic factors.

While inflation rates are rising in other countries, including the United States, Japan continues its ultra-accommodative monetary policy.

As a result, the IMF does not recognize any major criteria, such as market dysfunction, financial stability risks, or uncontrollable inflation expectations, that would justify intervention.

Japan’s Finance Minister Suzuki also believes that an “appropriate response may be required depending on the situation” regarding yen depreciation in the foreign exchange market, further supporting the view that the need for market intervention is low.

■　Conclusion

The ongoing discussions about Japan’s economic situation and the Bank of Japan’s policy include the focus on the yen depreciation trend, the delay in the Bank of Japan’s policy change, the inflation structure, the interest rate differential between Japan and the United States, and the importance of increasing real wages to achieve the inflation target.

Japan’s inflation rate has consistently exceeded its target for 17 months, but exchange rates, interest rate differentials, and international factors continue to support yen depreciation and U.S. dollar appreciation.

The Bank of Japan maintains a cautious approach to policy changes with the goal of achieving the inflation target by increasing real wages.

These factors are expected to have a significant impact on the future outlook for the Japanese economy.